Investing for Long-Term Change: Challenging the Conventional Wisdom

Abstract

So far, we have focused on cyclical patterns that recur in the US economy and their relative return implications for different asset categories. In addition, we have highlighted the important role played by secular trends in macroeconomic variables like interest rates and inflation in shaping investment returns. Of particular importance for the investment outlook is the return of interest rates and inflation to more normal historical levels from the unusually high real interest rate environment of the 1980s and 1990s, when tighter monetary policy was bringing down the trend in inflation. Restoring rates and inflation to the lower levels that prevailed in the 1950s and early 1960s has reestablished some structural relationships that were disrupted by the rising inflation environment that began in the mid-1960s. Once again, dividend yields on stocks are higher than yields on most Treasury securities, and dividends have become a more important source of the overall return to equities. Credit spreads are fluctuating around a new lower mean that reflects higher profits margins, like those that prevailed before high and rising inflation started to undermine business performance. Overall, real and nominal interest rates have settled back into a “new normal, like the old normal” range.